An expensive 'mistake': rail fiasco could cost taxpayer over £100m

Three civil servants suspended as Department for Transport prepares for compensation claims

The cost to the taxpayer of disastrous failings in the Government's rail franchise programme could exceed £100m, industry experts warned last night, as the Transport Secretary launched an urgent review of the fiasco.

The Department for Transport confirmed that three civil servants had been suspended after Patrick McLoughlin said officials had made a "terrible mistake" in the calculations for deciding who should be awarded the West Coast Main Line franchise.

Mr McLoughlin promised to refund the estimated £40m cost of the bidding process to all the companies involved and announced an urgent inquiry into what had gone wrong.

However, industry sources said the total cost could be far higher. Three further large rail franchises are due to expire in the next few months and bids for those contracts have now been suspended until the franchise review is completed.

If ministers are forced to restart those competitions from scratch they will face compensation claims from the companies involved for the work they have already done. They will also have to negotiate extensions to the existing franchises under what one industry source described as a "very weak bargaining position". "When all's said and done the cost of this to the Government is likely to be more than £100m," said one source close to the process.

Another said the sheer scale of franchise changes over the next year meant that the department would have little choice but to offer costly extensions: "They don't have the resources to run all these railways themselves so they'll have no option but to extend franchises that are next for renewal. It will cost them a fortune."

The Independent understands Mr McLoughlin was first made aware of problems in his department's handling of the bid a few days ago, but it was only after getting legal advice on Tuesday that he decided to scrap the process entirely.

However, some reports suggested that his predecessor Justine Greening may have been made aware of potential problems before she was moved in the reshuffle. If so, it would raise questions about why the Government defended its decision so aggressively.

Mr McLoughlin said yesterday that he was "very angry" about what had happened. "The fault of this lies wholly and squarely with the Department for Transport," he said. "I want to make it absolutely clear that neither FirstGroup nor Virgin did anything wrong. Both acted properly on the advice they were getting from the Department."

In August, with Ms Greening in charge at the DfT, the department announced that a new 13-year franchise for the West Coast had been awarded not to Sir Richard Branson's train company Virgin Rail, which had operated the line since 1997, but to rival transport company FirstGroup.

Sir Richard described the franchise process as "flawed" and "insane", and launched a legal challenge. But Ms Greening and, later, Mr McLoughlin contested this, saying they were happy that the bidding for the line had been "robust". The department dismissed Virgin complaints as "ill-founded and misconceived."

Speaking yesterday, Sir Richard said he was pleased that they had now acknowledged their mistakes. "We were convinced the process was flawed but despite our best efforts we were met with silence by the Department for Transport," he said.

Government sources said the fiasco highlighted significant weaknesses in civil service advice to ministers.

"The officials simply didn't do their job correctly and gave incorrect advice to ministers," said one. "It was a shoddy process and as soon as it became apparent what had happened we realised it could not proceed. We are now going to have to start clearing up the mess."

A first-class catastrophe: The key players

Sir Richard Branson

Sir Richard's decision to take the Government to court after he lost the franchise to operate West Coast Main Line services led to yesterday's revelations. In the run-up to the case, ministers had accused the Virgin boss of sour grapes – but it now appears that his stance has been vindicated.

Theresa Villiers

The former Transport minister responsible for trains robustly defended the Government's decision to strip Virgin of its franchise. She now faces questions about her oversight of the process.

Justine Greening

As Secretary of State for Transport, Greening had overall responsibility for franchising. But she was only in the job for less than a year and is likely to claim she was merely following advice from officials.

Philip Rutnam

The Permanent Secretary at the transport department should have overseen franchising on behalf of ministers. But Rutman was only given the job in March, having moved from the Department for Business.

Tim O'Toole

The chief executive of FirstGroup was delighted win the West Coast franchise in August. He now has to cope with a 20 per drop in his company's share price following the decision to tear up the agreement.

Q&A: How the franchise bid was derailed

Q. So what's gone wrong?

A. In assessing the competing bids to run the West Coast Main Line officials in the Department for Transport appear to have badly miscalculated the risk of the FirstGroup bid. It was offering to pay the Government £13.3bn over the length of the 15-year contract, but the amount of money due to be paid each year was heavily skewed towards the back end of the contract.

In order to prevent the company from walking away early (and not paying the later higher payments) the Department demanded a "shareholder loan", which the winning bidder forfeits if it terminates early.

The DfT demanded £190m off FirstGroup. But, when Virgin Rail ran the numbers, it calculated that if the department had correctly followed its own rules that number should have been closer to £600m, given the extra risks caused by FirstGroup's "back-ending" of payments.

Q. How did the mistake come to light?

A. Unhappy with losing its franchise Virgin decided to take the Department to court. In the course of preparing its defence the mistake came to light. The new Transport Secretary, Patrick McLoughlin, requested advice from counsel on whether in the circumstances the Government could argue that the contract had been awarded fairly. He was told that it could not.

Q. What happens now?

A. The Government is to run the entire bidding process again, and will refund the £40m the companies spent on the process. This is likely to take many months not least because the officials who would normally be in charge of the process have been suspended. It is still unclear what will happen in December when Virgin's contract is due to run out. The Government could step in – and like East Coast Trains – run the franchise temporarily itself or allow Virgin an extension.